2016: THE YEAR CHEAP MONEY ENDED

At last in December the Fed finally decided that the economy was strong enough to head towards normalizing interest rates. A single quarter point rise in itself was not terribly meaningful; however, the market is more than doing the job for the Fed. The 10 year Note started around 2.25% in January, with the economic uncertainty and Brexit rates fell to a low of 1.40% in July and since that time has steadily risen to close the year a touch under 2.5%. Were it not for perhaps the most unexpected federal election result in decades this increase would be viewed as unprecedented. In other credit markets we have seen spreads generally widen the farther you go down the credit quality spectrum.

All of this cheap money has been driving corporate m&a activity to new highs. Deal volume in the US will come in around $1.7 trillion driven largely by big corporate mega deals. Ample cheap debt funding has been available for even the more speculative transactions. Activity in the middle market likely slowed down from 2015. Expectations for 2017 are good for large-cap consolidation transactions (on the expectation that a Trump FTC will be less restrictive). Activity in the middle market, which tends to be more credit sensitive, will likely continue at a similar pace. Driving middle market activity is the fact that PE Buyout firm fund raising remained strong in 2016. For rates to seriously slow activity, we would need to see more than 150 basis points in rate hikes by the Fed.

Speaking of rising rates, a longer-term impact will be felt in terms of company and asset valuations. In the private market, values tend to be reflected as the present value of discounted future cash flows. Thus big ticket assets like commercial real estate and timberland may find values under pressure as the year goes on, assuming the Fed follows through on its rate normalizing plan. In the public markets the drivers include growth rates (earnings and revenues) and WAC (weighted average cost of capital). Rising rates are not a direct negative for stock values, but as an asset class, rising long term rates do tend to cause a shift from equities to fixed income in asset parity valuation models. Contact Jeff by email.